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May 30, 2012

Spain Spooks Investors as Eurozone Confidence Falls

The Spanish bank crisis escalated Wednesday, frightening investors away from markets that fell to their lowest level in nine years, as economic confidence in the euro zone declined and polls showed that Greeks favor changing the terms of their latest bailout.

Meanwhile, the European Central Bank (ECB) said that none of the nine countries that are prospective members of the eurozone were in good enough financial shape to join.

Reuters reported Wednesday that Madrid said it would look to credit markets to find funds to pour into Bankia, the country’s fourth-largest bank, which is already nationalized. However, 10-year borrowing costs are hovering near their euro-era high, at 6.67%, and Spain still says it will not look for outside help to extricate itself from its financial woes.

The Economy Ministry also denied reports that appeared in the Financial Times saying that the ECB had turned down a plan to save Bankia by funding it with government bonds that could then be used as collateral to borrow from the ECB.

"Spain did not formulate any proposal to the ECB on funding the Bankia plan, so it was difficult for it to have an opinion," said a ministry spokeswoman in the report. "The Economy Ministry maintains as a first option to go to the markets to recapitalize the entity."

Avoiding outside help appears to be getting more difficult as the days pass. On Tuesday, Bank of Spain Governor Miguel Angel Fernandez Ordonez suddenly resigned, a month before the end of his term. That added to speculation about how the Bankia crisis was being handled and how Spain would manage to work with the ECB and other such institutions.

Ordonez also warned on his departure that tax revenue may come up short compared to government expectations and that spending could be higher than projected.

However, the European Commission (EC) backed Spain in a call for direct aid from the eurozone to banks in trouble, instead of requiring that the money be channeled through the country’s government. It also spoke out in favor of joint euro-area bonds.

If the eurozone’s permanent bailout fund were to provide cash directly to banks in trouble, said the EC in a Bloomberg report, it would “sever the link between banks and the sovereigns.” The EC also called for a “banking union” that would supervise more closely those banks with cross-border exposure, would put together a European fund pool to be used to rescue those banks and also segregate their underperforming assets.

The rumbling over Greece may have subsided for the moment, but there is still turbulence beneath the surface. Although polls showed that pro-bailout parties have gained in the polls, narrowly trumping Syriza, the party favoring a rejection of the bailout, a majority of Greeks still favor renegotiating the terms of the bailout.

While 80.9% of Greeks surveyed said the country should do whatever it has to in order to stay in the euro, 77.8% also said that the terms of the bailout should be renegotiated by the government after the next election in June.

The National Bank of Greece (NBG) has been warning the country of dire consequences should it exit the euro. Only hours before it was due to report first-quarter earnings, it issued a caveat about crushing consequences should the country leave the currency. In a statement, it was quoted saying, "An exit from the euro would lead to a significant decline in the living standards of Greek citizens."

NBG added that per-capita income would plummet by at least 55%, the new drachma would be worth 65% less than the euro and an already-five-year-long recession would deepen 22%, amid skyrocketing inflation and unemployment.

Such prognostications are taking their toll on the eurozone as a whole. Bloomberg reported that the EC released figures Wednesday showing a fall in economic confidence in the euro area that was steeper than predicted.

An index of executive and consumer sentiment in the bloc dropped to 90.6 from a revised 92.9 in April, hitting its lowest level since October 2009. A Bloomberg survey of economists had predicted a median of 91.9.

“All second-quarter sentiment indicators seem to signal a fall back into recession territory,” Peter Vanden Houte, an economist at ING Group in Brussels, said in the report. “European leaders will have the difficult task to find a way out of this doom loop.”

Even if the eurozone were in better shape, prospective members aren’t—although they aren’t all that eager any longer to join up. Eight nations are on its waiting list, but according to the ECB none of them meet the standards required to become a member. Only Latvia is in a position to manage it in two years.

In its latest convergence report, the ECB said, "In none of the eight countries examined, the legal framework is fully compatible with all requirements from the adoption of the euro as laid down in the Treaties and the Statute of the European System of Central Banks and of the ECB."